Peter Thiel On The Seven Questions A Startup Must Answer

Peter Thiel, in his book Zero to One, laid out seven questions that a startup must answer in order to be successful. The book itself is one of my favorite business books to date, and certainly plan on re-reading it.

His seven questions:

1. The Engineering Question: Can you create breakthrough technology instead of incremental improvements?
2. The Timing Question: Is now the right time to start your particular business?
3. The Monopoly Question: Are you starting with a big share of a small market?
4. The People Question: Do you have the right team?
5. The Distribution Question: Do you have a way to not just create but deliver your product?
6. The Durability Question: Will your market position be defensible 10 and 20 years into the future?
7. The Secret Question: Have you identified a unique opportunity that others don’t see?

As Thiel puts it, if you don’t have good answers to these questions, you will most likely have “bad luck”, ie fail. “If you nail all seven, you’ll master fortune and succeed. Even getting five or six correct might work.”

Engineering

Can you create a breakthrough technology instead of incremental improvements?

The premise of the book is that in order to create a truly innovative product/company, you must be 10x better. One to n is only incrementally better, whereas zero to one is infinitely better.

Companies must strive for the 10x better because merely incremental improvements often end up meaning no improvement at all for the end user.

Steven Johnson, in his book Where Good Ideas Come From, wrote of the “adjacent possible”:

The adjacent possible is a kind of shadow future, hovering on the edges of the present state of things, a map of all the ways in which the present can reinvent itself.

The adjacent possible “captures both the limits and the creative potential of change and innovation.” The boundaries of the adjacent possible grow as you explore them, and each new combination opens up the possibility for other combinations.

The greatest thing about the Internet is access to information, particularly the cutting edge research. The ability to find what what top institutions are figuring out and reading their papers gives the curious engineer the ability to take that new research and see how it can apply to an unsolved problem. The adjacent possible is very similar to what a PhD student does. These two images clearly illustrate what a researcher is doing the knowledge of their field.

The adjacent possible is very similar to the border that the researcher pushes. Creating a 10x better product means figuring out what is at the adjacent possible, and combining it with other breakthrough research to produce an outcome to an unsoled problem that people have.

Timing

Is now the right time to start your particular business?

Sequoia Capital asks every startup their famous question: Why now? The right time to start a business is critical. Certain companies and technologies could only take place due to previous technologies. Tim Berners-Lee, creator of the Web, was able to connect different hypertext markup pages to other people because of the TCP network platform already established. Twitter was only able to exist because of the state of the internet at its time. With any new technology, there is a new set of problems to be solved. The birth of the internet presented the problem of how to find things on it (Google). After that problem was solved, then it was how do you find people on it (Facebook). Each of those problems had numerous solutions before hand, and it was only until Google and Facebook created a zero-to-one product that they came out successful. A common problem now is how do you make sense of the enormous amount of data we have.

Here is Marc Andreessen on timing in answering Thiels question What truth do you believe that very few people agree with you on?:

A thing I believe that few believe: Almost all Silicon Valley startup ideas from qualified founders = great ideas. But some are too early. Track startups over multiple decades, what you find is that most ideas do end up working. It’s much more a question of “when” not “if”.

This is interesting for several reasons. First, it means that criticism of the form “that will never happen” is usually misguided & wrong. Second, it means that a much bigger risk for founders is “too early”, vs “wrong” or “too late”. Often doesn’t match feedback from others. To quote Peter Thiel, it is often better to be the last company to market (hit timing right & take down the entire market) vs the first.

Third, when you have the timing right, you almost always feel like you’re too late. Terrified you’ve missed the window = great sign. When idea X has been in the air, with repeated attempts to build X, yet most customers are not yet doing/using X, it’s never too late.

Fourth, founders by definition live in the future, see a world that doesn’t yet exist & try to make it so. Nailing timing = hardest thing. Which is often why more pragmatic founders end up building the big & important companies — the idealists were just too early. Fifth, therefore, most of the great ideas for the next two decades are already known. In labs, in failed startups, in big co prototypes. Those ideas are being dismissed now since the early attempts have’t worked. This has the opposite predictive value vs what people think.

Quoting William Gibson, the future is already here, it’s just not evenly distributed — or it’s not yet distributed at all. But it is The key question is: What ideas are widely dismissed today due to having been tried & failed? Answer is the codex to the next 20 years

The timing question is tied to the engineering questions. Many people look at new research being done and try to apply it to problems of today. A lot of them fail. Sometimes those failures are a result of not making the proper connection, and have thus been dismissed. Timing is really about looking at new research that has been tried and failed, and seeing what those attempts have missed, and attempting to solve the same problem with a new solution. Google[x]’s “solve for x” is a great picture that illustrates this:

Monopoly

Are you starting with a big share of a small market?

Large markets are not the best markets to build a startup. Ruthless competition — a result of large markets — makes it difficult for innovation to happen. Conventional wisdom says to target large markets because there is a greater opportunity and more room for growth and profits. One percent of a $500 billion market is a lot of money. Yet, as the theme in Zero to One, conventional wisdom is usually approach you do not want to take.

Taking a big share of a small market means you have monopolistic power within that market. Being the only, or one of the few players in that market means you have both the freedom to innovate on the core product and high profits. In highly competitive markets, you do not have the freedom to innovate because your focus needs to be on survivial. Conventional wisdom in economics says that when there is competition, the companies will develop more innovative products. Innovation happens over a long time horizon. The “innovation” that companies in competitive markets produce is exactly the incremental improvement that Theil talks about. It is near impossible to produce zero-to-one, 10x improvement on a product when there is a lot of competition.

A lot of big companies don’t go after a small market because it doesn’t meet their revenue objectives. A $10 million market to a $10 billion company isn’t really worth allocating resources to, but that same market to a startup where there aren’t many players and no one has developed a zero-to-one — 10x — product is the best market you can go after because you do not have to go up against the large companies, with their countless resources.

People

Do you have the right team?

You need technologists to build a successful, innovative product. Here is Thiel on what he observed was happening in with green energy startups:

The most obvious clue [to determine if you have the right people] was sartorial: clean-tech executives were running around wearing suits and ties. This was a huge red flag, because real technologists wear T-shirts and jeans. So we instituted a blanket rule: pass on any company whose founders dressed up for pitch meetings. There’s nothing wrong with a CEO who can sell, but if he actually looks like a salesman, he’s probably bad at sales and worse at tech.

Distribution

Do you have a way to not just create but deliver your product?

With software startups, distribution has become very easy. Deploying to any one of the cloud hosting services (AWS, Rackspace, DigitalOcean, Heroku, etc) is easy and everyone is already on the internet. Distribution isn’t simply to make your product accessible, but it is to get it into the hands of the customers. This is tied to the market question. Going after a large market makes it very hard to get your 10x product into the hands of a lot of people.

Conventional wisdom says that if your product is truly a 10x product, then it will spread by its self, word of mouth, no need for marketing. The first thing Marc Andreessen and Ben Horowitz at a16z advise founders is that they need to hustle to get their product in the hands of people because the world is a very big place. The internet did not have many people on it during the early years, and so the conventional wisdom if “build it and they will come” applied back then. Today, and the future, the internet is very crowded. When Pinterest wasn’t picking up any steam, founder Ben Silberman would go into Apple stores and literally put the site up on the computers for customers to see. They ended up kicking him out of the stores.

From the perspective of companies that develop consumer related products, the most precious element in this age is our attention. Literally every company is vying for our attention. The more attention we give them, the more money they make and the further they grow. Now we only give attention to things we value. We give our attention to products that appeal to us, solve our needs, entertain us, and give us enjoyment. So the only way to gain peoples attention is to solve a real problem that a specific group of people have — small market — and the solution — the product — is orders of magnitude better than existing solutions.

Its not always good the be the first to market — another contrarian statement Peter Thiel makes in the book. It is much easier to look at a market that many people have gone through and failed, see what didn’t work and why, and then go after solutions that have not been tried yet. Google is the best example of this. The 17th search engine was late to the game, and the conventional wisdom at the time was that the internet will be accessed through portals, ie Yahoo! Larry Page made a connection between the similarity of web pages and research papers, and out of that connection created PageRank.

The internet at the time was picking up and Page did not set out to solve the problem of searching for things on the web. He set out to solve the problem for searching for papers within the Stanford databases — a small market. The students and faculties within Stanford was a market that very few, if any, people/companies were vying for — a monopoly.

Durability Question

Will your market position be defensible 10 and 20 years into the future?

Peter Thiel said that the valuation of a company is in their cash flows that come in 10 years time. He said that in 2002, 80% of the value of PayPal came from cash flows received in 2012. The reason people are shocked at how Twitter or Uber could be so highly valued is that they are looking at their value today, not their value in 10 years.

The durability question is important because when entering a small/new market, that market takes time to grow. And so the value of a startup is the growth of its product within the small market over the course of the maturity of that small market. All the more reason to be a monopoly within that small market, so you could grow as the market grows without competition.

Secret

Have you identified a unique opportunity that others don’t see?

Secrets are transparent in retrospect. It is obvious to us the relationship between a triangle’s three sides, yet it took Pythagoras many years to uncover how they related to one another. The big question in Zero to One is what important truth do very few people agree with you on? Thiel writes:

“Every correct answer is necessarily a secret: something important and unknown, something hard to do but doable. If there are many secrets left in the world, there are probably many world-changing companies yet to be started.”

A better question to ask is are all the hard problems solved? Conventional and the “flatness” of the world, as described by Thomas L. Friedman, makes us believe that if there were any secrets left, someone would have figured it out. Most good ideas don’t look like good ideas to begin with and a lot of horrible ideas also do not look like good ideas. Thats the reason a lot of top investors focus on the founders over the idea. A great founder can take an idea and make it better, whereas a bad founder with a great idea will fail at building a company.

Secrets today are often crazy enough that they might actually work. When building a company, the reason why its better to build it off a secret is that there are less players in the market and you are not fighting with the giants in the industry. Mobile payments are not secrets; all the big companies are doing that and you can’t win against them while playing the same game — unless you know a secret that they do not and that most people would disagree with you on yet its true.

Bitcoin is an interesting example. The applications of what Bitcoin can be used for today are known. Remittances today, usually done through Western Union, charge a large fee to send money to another country. Bitcoin can make it much cheaper by converting one currency to Bitcoin and then from Bitcoin to the other currency. The exchange cost is trivial and it doesn’t matter if the Bitcoin price fluctuates becuase the transaction is near instantaneous. Also with card fees. Banks charge an average of 1–3% per transaction fee — a cost that the receiver must bear. Bitcoin can be replace that fee the same way it would do to remittances. There is not fee when transferring cash, and likewise the fee for transferring money through bitcoin is trivial.

The secrets of Bitcoin are still plenty. Bitcoin today looks like what the internet was when it first started. The internet, even before the web, was simply a distributed system for the transfer of packets (pieces of information) over a network. All the applications that got built on the internet could have not have been predicted when the internet first started. Likewise, all the applications that will be built on top of Bitcoin are secrets.

These seven questions are great guiding principals for building a startup. Not failing at a startup — a thing people are somehow proud of — is very difficult. These questions are a framework for thinking about the future of a startup and its value.

Originally published at seekingintellect.com on January 12, 2015. Subscribe to the Seeking Intellect Newsletter.